Can European politics damage the euro?

It is often fashionable to worry about European politics as newer parties of the right, left and centre emerge to challenge the economic orthodoxy of the Eurozone. We saw this at its most spectacular in Greece, where Syriza swept aside the old parties and gained a majority in a proportional system designed to make that difficult. Syriza then discovered it was easier winning an election than breaking free from the euro’s restraints. The Greek public did not wish to withdraw from the euro which would have been the only way to stop the budget cuts and tax rises. Last year in France a new movement had an even more commanding victory over the traditional centre left and centre right parties, but on a ticket which aims to strengthen the euro area and its governance.

This year dawns with worries over the situation in two of the large euro area countries. In Germany Mrs Merkel has to resume talks with other parties to try to pull together a coalition to sustain her in office. Her best bet looks like a resumption of Grand Coalition with the SPD, despite their early insistence they wish to be in opposition. She also has to keep her CSU allies happy, when they are trying to drag policy in the opposite direction to the parties of the left that Mrs Merkel needs to woo. We assume there will finally be an ambiguous deal to keep in power a much weakened Mrs Merkel, as both the main parties in Germany could end up with a worse result if they opted instead for a new election. Polling since the election shows the Greens and the AFD anti-euro party might do better second time round at the expense of Mrs Merkel’s CDU and the SPD. This will mean President Macron of France will have a stronger position within the EU, and the EU Commission is also a potential beneficiary.

Markets have got used to relying on the European Central Bank (ECB) to determine the outcome for the Eurozone economy

In Italy markets are now expecting a General election in early March. The latest opinion polling shows no party or pre planned coalition likely to win a majority. The radical 5 Star Movement is ahead of all the other parties by a decent margin, but is on just 29% of the vote. The Democratic party (centre left) is in second place on 22.8%. Forza Italia and the Northern League, centre right and more hostile to the Euro scheme than the Democratic party are on a combined 28.3%. It looks likely that Italy will vote for a Parliament of varying voices, where creating a stable coalition government will be difficult. For that reason we do not expect Italy to produce a government that wishes to take the country out of the euro. 5 Star itself has placed less emphasis on its dislike of the euro since the election of 31 year old Luigi di Maio as leader. The aim would be to negotiate some fiscal latitude for Italy within the single currency scheme. Without the pressure of a realistic threat of leaving the euro it is difficult to see how seeking talks on this with the EU could achieve much.

Markets have got used to relying on the European Central Bank (ECB) to determine the outcome for the Eurozone economy. Fiscal policy is parked by Treaty commitments and by German insistence on keeping the discipline of low budget deficits throughout the zone. The absence of large transfer payments from rich to poor puts the pressure on the European central Bank to ease the situation through a loose money policy. 2018 should see more of the same. It is true the Bank is reducing the amount of special stimulus it provides through money creation and bond buying, but it shows no signs of wanting to push up interest rates to tighten money policy substantially. The ECB seems to hope that commercial banks with stronger balance sheets after recent repair will be able to lend more as an offset to less official bond buying.

We will be watching the ECB and its words very carefully again this year, as will most professional investors. They have managed to bring about a recovery, after years of crisis management as they first impeded private sector credit from overstretched commercial banks and more recently have sought to resume a more normal pattern of commercial lending. It looks as if the economic recovery can continue. The politics of the Eurozone leave little scope for member states to use fiscal policy to promote their aims. So far it looks unlikely that an anti-euro party will win an election outright and carry through a policy of leaving the zone.

The above article was first published by Charles Stanley on 2nd January 2018

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